Officials are investigating the possibility of a carbon dividend, where revenue from the emissions trading scheme or a carbon tax gets recycled back to households.
Proponents of the policy, which has been adopted in parts of Canada, argue that it helps make a higher carbon price more politically viable, as households are supported through the transition to a low-emissions economy.
From a peak of more than $85, the price of a tonne of carbon, measured in tradeable New Zealand Units (NZUs), has collapsed to just over $50 on the secondary market after the cabinet rejected advice from the Climate Change Commission (CCC) that would have tightened supply.
Commentators have described the impact of that decision as shattering confidence in the emissions trading scheme (ETS), with politicians unwilling to risk higher carbon prices driving inflation up and causing political damage as well, particularly in an election year.
A spokesperson for the Ministry for the Environment (MfE), which administers the ETS, said the government is exploring a range of tools to address the distributional impacts of climate change and climate change policies.
“One of the tools being explored includes the possibility of a mechanism such as a carbon dividend,” she said.
“However, analysis is still in the early stages and no government commitments have been made.”
Eric Crampton, chief economist at the NZ Initiative think-tank, said a carbon dividend made it easier for governments to let carbon prices rise and the case for it has been obvious for years.
“The best time to introduce a carbon dividend would have been when ETS revenues were first ring-fenced to their own separate fund,” he said.
“Since then, they have been used for useless industrial subsidies.”
The second-best time to introduce a dividend is now, Crampton said.
Because NZ has an ETS rather than a carbon tax, carbon revenues will eventually drop to zero when the government stops auctioning NZUs.
This means any dividend will function as a transitional payment to help households through their own transition to a higher carbon-cost world, Crampton said.
“It would be just great if the government could get on with this before the opportunity ends.”
Ministers do not share Crampton’s opinion on the best use of ETS funding and feel it is better to directly drive emissions reductions through subsidies such as those given to NZ Steel on the weekend.
However, parties at both ends of the political spectrum – ACT and the Greens – have both supported the idea of a carbon dividend.
The cabinet decided to recycle ETS cash through the Climate Emergency Response Fund (CERF). This was created in Budget 2022 to provide a dedicated funding source for climate-related initiatives distinct from core budget allowances.
For a while, it looked like it was going to earn bumper revenue for the government. This changed with the collapse of the carbon price last year, combined with the decision to maintain spending levels, resulting in a forecast shortfall between ETS revenue and funding allocated via CERF.
CERF was set up with initial funding of $4.5 billion, equal to the forecast ETS cash proceeds from the 2022-23 to 2025-26 years at the Half Year Update for 2021.
In last week’s budget, the government reduced the funding available by $0.8bn due to the fall in carbon prices, with the Treasury forecasting a future constant price of $54.50 for NZUs.
However, ministers have topped up the CERF fund allocation above and beyond what the Treasury expects will be raised from the ETS.
In all, the government has now made available $6.6bn of funding in the CERF, but the ETS proceeds are only expected to generate $4.7bn, with the Treasury assuming the $1.9bn shortfall will be met from borrowing.
Taking into account spending allocations already made, there is $1.5bn left to spend or distribute in the CERF fund over the last three years of the forecast period.
Of course, if carbon prices go up or down, the outlook could change rapidly.
For example, a $10 decrease or increase in the price of NZUs would result in a $0.6bn change in ETS cash proceeds from the 2023-24 year.
There is also the slight possibility of earning no cash. The last auction did not clear and failed to raise any money as the bids fell below the confidential reserve price. In theory, this could happen again although, at some point, those who need NZUs to settle their emissions with the ETS will have to buy them from somewhere.
The government is also considering several areas which could change ETS settings and the carbon price, with a four-week consultation underway, ending June 16.
One of these is the CCC’s latest advice on ETS auction limits and price control settings for NZUs.
The commission essentially repeated its last round of ignored advice: further reduce the number of NZUs auctioned, lift the reserve price gradually to reach $79 in 2028, and set much higher limits to trigger the release of more NZUs from the cost-containment reserve.
The CCC wants a two-tier cost-containment reserve, with a low trigger price of $205 in 2026 gradually increasing to $226 by 2028, and a high trigger price of $256 in 2026 gradually increasing to $282 by 2028.
The cabinet declined to do this last time because of fears the carbon price would move to the trigger level and create large inflationary pressure.
There is also a wider review of the ETS, as well as debate about the treatment of forestry in the ETS and agriculture emissions.
Another part of the budget included a reference that implied the government is pressing ahead with setting up its own secondary carbon market platform.
The budget set aside $38 million over four years for market governance regulation to increase the integrity of the ETS and reduce the risk of misconduct.
This includes developing a new carbon trading platform, an idea which has angered those already running secondary market platforms who say it is unnecessary and a waste of taxpayers’ money.
Officials seem keen to have greater transparency about pricing and trading, as well as more diversified NZU derivatives being made available.
Private sector platforms say this could be done with regulation and note the government already owns one carbon trading platform, run by a Transpower subsidiary.
Consultation documents have also referred to fears of market misconduct without any detail of this occurring.
A number of people who have to buy and sell NZUs to settle their emissions on the ETS, as well as those who trade them as a commodity, say the closest anyone has come to market misconduct is the government itself.
Last year, the cabinet decided to ignore CCC advice, but did not publicly release the decision until after a carbon auction was held, either not understanding that carbon prices would crash or withholding the information to maximise revenue.